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- [00:00]
Julian
I'm running risk as we speak. I'm like holding on for dear life, you know, because this is where you make your most money. But I'm not naive enough to think that this isn't. There's an incredible vulnerability here if something does go wrong. I will say this of macro. Most of the time it isn't the driving influence, it's supporting actor. But at times it is absolutely the central role at the tops and the bottoms. If this administration gets what it wants and is forceful at getting control of the Fed, then this is what I keep saying to my US clients. You are going to underperform by staying invested in the US asset markets. I'm not saying they're going to crash. Right. I am a little concerned with some of the movement seeing in the markets at the moment. Right. But you are just going to massively, massively underperform. And I think frankly, it's part of the plan.
- [01:00]
Justin
Julian, welcome to Excess Returns.
- [01:03]
Julian
Thank you very much for having me. Gentlemen.
- [01:05]
Justin
You are a co founder and president of Macro Intelligence Partners, also known to some as Mi2. It's a global macro strategy research firm that advises hedge funds, institutional investors and asset managers around the world. You and your partners are known for connecting the dots between economic data, policy, market price action and translating that analysis into practical and tradable investment strategies. And today we wanted to talk to you about a number of things, sort of talk about your view of the market and the framework that you're using to navigate today's macro landscape. So I think we'll get into some things around inflation, the Fed's shifting policies, US exceptionalism, capital rotation and possible shifts in the market, and a bunch of other things that I think are important in this macro environment. You can learn more about mi2mi2partners.com so Julian, thank you for spending this time with us today. We appreciate it.
- [02:02]
Julian
My pleasure.
- [02:04]
Justin
One of the things that you have talked about and emphasized is sort of the importance of being tactical and long assets when the time is right and not taking this permanently bullish sort of stance that, you know, some people in the macro world do. So can you just talk us through sort of how you think about using macro analysis and when you think it adds the most value to investors.
- [02:33]
Julian
So I, if I may, I would correct you a little bit. I wouldn't say in the macro world, I think in the broader investment world. Okay, right. We have, and I think it really comes down to, it boils down to, and this is going to be quite controversial, the quality of the individuals that you get in most of the financial industry, right? You know, this covers a plethora of people, a broad spectrum, you know, from, you know, good to exceptional and most people. And also it comes down to a lot to how people are remunerated. Most of the financial industry is remunerated via the accumulation of assets, right? They want you to be fully invested. And when they say, you know, you can't time the market, they mean they can't time the market because either they're too big or they're just not capable of doing it. They're not good enough to do it. Most wealth managers are not good enough doing it. They take a very passive approach to asset. Asset allocation, which is in these big firms, is all chucked out by central management these days. And it's designed not to make you money, but to ensure that you don't lose money and sue them, which means that you never make that much money, right? So I think, you know, and you've also got to extend this out even further to the financial news industry and particularly some of the TV channels whose whole advertising revenue is how they make money. And their advertisers tend to be, you know, spending a lot of money when the market is going up. Few people are advertising, you know, their latest ETF strategy or their latest blah, blah, blah, you know, platform when the market's in the toilet. And so I think you have a whole industry that is, for want of a better term, and it's going to be very controversial. Bunch of cheerleaders, right? They are simply a bunch of cheerleaders. And the momentum chasers, I think the analyst community is probably some of the worst. And that's just not how large and significant portions of the financial markets are orientated. So if you look at the hedge fund world, the hedge fund world is not orientated around there. They're orientated about making money and not losing tiny amounts, right? You lose your seat at a hedge fund if you lose a tiny amount of money, right? So you cannot adopt this, you know, balls to the wall, I'm just long risk type approach. You have to manage risk appropriately. And as part of that process, macro is very important because macro, I will say this, with macro, most of the time it isn't the driving influence, it's supporting actor, but at times it is absolutely the central role at the tops and the bottoms. It tends to be the determining factor because it starts to weigh either or direct the flows at those highs and lows in terms of just cutting off either the extreme pessimism or the Extreme euphoria by giving a taste of kind of reality. And yes, we've seen distortions come in through central banks, Right. Who have this ability now just to print money. And we get, you know, as we saw during COVID levitation of assets in an environment of imploding economics. Right. But that macro comes in at these times and I think frankly it's pretty hard in my, I've been doing this for almost 40 years career to see a time that's been a better macro time.
- [06:30]
Justin
Yeah, And I think we'll, we'll get into that in a second here, but let me. Well, let's go there. So I mean, why, why do you think, why do you think it's such a fruitful environment for this type of macro analysis?
- [06:46]
Julian
So I think, look, we've essentially been playing this kind of game for the last few years where we've had this sort of accelerator, break type movement within a general bull market, which is justified of times where the bond market starts to apply some sort of break to the enthusiasm of the equity market, either because it starts to see inflation coming up, or times quite the other way where it starts to sense sort of weakness and problems. And we keep playing this sort of accelerator and break thing. So that's within a broad trend. That's where macro kind of plays, tapping the bottom and the top of an upwardly sloping sine wave. And okay, so that's a standard macro cycle. The second thing is clearly the policies of the Trump administration are transformative if they deliver, right. This is an administration which right from the get go, on the eve of the election, we wrote a story about breaking eggs and we said, guys have got no idea what's coming down the pipeline. We've got lots of policy friends from my days when I worked at Media Global Advisors who, you know, go and talk to politicians directly. We don't, but they do. And it was very, very clear that these guys were coming out with a very, very, very radical agenda. And the street was like, no, they're not going to impose tariffs. Oh no, no, no, they're definitely not going to do this. Oh, they wouldn't do that. And of course we've got them all. And now they're like, oh, but they don't matter, right? These do matter, right. For all the spin that we get from the politicians, tariffs are just a cute way of applying an enormous great VAT onto US Consumers. You can calculate exactly where that rate, you know, ends up, but it is a vat, right? At the same time, the immigration policies, while Arguably, I'm not saying any of this isn't long term laudable aspirations, but there is an adjustment process. Right. Are restrict trend growth. Literally restrict trend growth, because trend growth is a function of the number of people, of working, how many hours they're working and productivity. Right. So if you have fewer people working, your trend growth is arguably significantly lower. Right. And you could argue, I think it's easily arguable that trend growth in the US is no more than 2% at the moment. Right. And you know all of these, and then you've got the dollar policy. Right. Which I think is quite justifiable. We have an extraordinarily expensive dollar. Right. That's from a macro perspective is one of the most important things. This is the thing that we've played right since the start of the year. And all of this is occurring when the world has never had more money invested in the US Right, in the last five years. The rest of the world, to fund our exceptionalism, spending like a drunken sailor is not exceptional in my book. Okay, but to fund our exceptionalism has poured $20 trillion into U.S. assets. Those are absurd amounts of money. And we just expect it to keep going as we try and intentionally reduce the value of the dollar. Good luck with that. Right. So since the beginning of the year, I mean, look, we've been big gold bulls for two years now. We got in at like 1800. But since the beginning of the year, my personal portfolio and some of the stuff that we've been resting has been invested in everything that is not exposed to the US So I've got like, you know, I was on another podcast, they said I've got all the crap in my speculative portfolio. I've got silver, silver miners, junior silver miners, gold, gold miners, XME. And they blown away, blown away mag7. And yet all we hear on CNBC and even Bloomberg is oh, the S and P made a new high today. And oh, look at the Mag 7. They are underperforming guys. And if this administration gets what it wants and is forceful at getting control of the Fed, then this is what I keep saying to my US clients. You are going to underperform by staying invested in the US asset markets. I'm not saying they're going to crash. Right. I am a little concerned with some of the movements seeing in the markets at the moment. Right, but you are just going to massively, massively underperform. And I think frankly it's part of the plan. When Scott Bessant said when he came to office, more Americans went to Europe last year on holiday in the same year that more people drew food stamps. That's wrong. And he's right. That is absolutely morally wrong. So I think in five years time, if they can rebuild manufacturing, give those people on food stamps a job, but screw the wealthy so that next time they try and go to the Amalfi coast, they go, how much? They will have done a good job. But it does mean As a US investor, you might have lost 30 to 40% of your purchasing power, if you want to put it like that, your true wealth when compared to if you put your assets in something outside the.
- [12:30]
Justin
US I just want to, I don't want to lose this thread and we'll come back to it, but there's a process question I have for you because I think it's important as we talk about all these things with you, and that's how you use sort of price action or price confirmation when you're actually developing strategies or ideas around some of these themes. So I know that's part of what you do as a firm. And so I think as just before we go too far along, like, can you just talk to that and how that's sort of implemented?
- [13:02]
Julian
Absolutely. So we've had this theme that, as I said, that everyone's been that the strong dollar actually somewhat counterintuitively attracts money into U.S. assets. So we've always had this thesis that, you know, U.S. profits are low when the dollar is strong because we've got an S and P that's very exposed to the rest of the world and their revenues get hit. Doesn't actually work like that. What really just blows it all away is just flow, flow of cash. So when the dollar is strong, foreigners want to pile money into the US because they can double debt. They get a strengthening dollar against their own currency and US assets tend to outperform as that flow of money comes in. And so we've been sort of looking at this setup and going, there's a fragility here. We don't like that. Right. But you can't jump in front of the steamroller. You have to wait for the price confirmation. You can have a thesis, and that's very important to have a lean, a bias things that you're looking for. Because if mentally you're set up for them, you're ready to act and you know what to do as and when those events occur. But until you get the confirmation from the price action, it's a pointless exercise trading it. Right. You're almost always too early, like mentally, definitionally that is almost the case. So at the start of the year, we started to look at things like, you know, you can, if you create a log chart of xlk, which is the tech etf, right, against xme, which is the mining's metals. And if you go back and you look at cycles in the dollar, XME tends to be one of the best performers when the dollar is weak and it is one of the worst performers when the dollar is strong. And obviously we're coming out of a period where the dollar's been extraordinarily strong. And conversely, XLK tends to be one of the worst performers when the dollar is weak and one of the best performers when the dollar is strong. So you look at that as a pair trade. You look at the trend lines, you do a little bit of technical analysis, right? You get the break, you go with the trade and that's what happens. And you know, XLK, XME is like up 100%, you know, so far this year. Right. So that's, that's how you do it. So there is a process. Mentally get prepared. You kind of look at positioning. Does anyone have this or. It was pretty clear that they were all long XLK and they didn't have xme. And then you wait for the technical signal to put your trade on and you get a decent risk reward trade there.
- [15:48]
Jack
And it's interesting to your international over US thesis. In a previous podcast, we just had a chart up and this goes to your point before, we had a chart up of the best performing countries in the world this year. And the US is not near like there's a ton and ton of countries that particularly a lot in Europe too outperformed the US significantly this year.
- [16:03]
Julian
Yeah, I think people really do forget this. I mean, if you're a European investor, particularly in a strong currency like the Swedish kroner, you're not up on the year in US Stocks. You're down. Right. I mean, I think people forget there is a. There's a lot of what I call. And this is, this is why I really, really do urge your listeners, watchers to think outside the box. Because we have a setup in the industry that is, especially in this country that is so myopically focused on the US that they don't mentally, they don't even think about what's going on in the rest of the world. And the reality is you'd have been far better off having your assets in the rest of the world. And these guys aren't set up for you to be, you know, to have assets outside they don't want you to have assets they don't want you. They're not capable of thinking about, you know, gold and silver miners that you should be owning. Right. They're quite happy to talk about Nvidia till you're blue in the face. Right. But this is, this is something that you really need to think about and do your own homework on.
- [17:12]
Jack
Yeah, it's interesting to think about, like what type of time frame it takes to break that, you know, because I've been, I'm a big advocate of international investing and have been for a while, but I've also been wrong for a while and like, people have just gotten used to, you know, for 30 years or whatever, this hasn't worked. And I wonder how long it'll take before investors will say, all right, right, maybe I should consider this. And it'll probably be, you know, it'll probably be at the wrong time. People chase things at the wrong time all the time. But it's interesting to think about, like what time frame that will take.
- [17:36]
Julian
No, I think, I mean, what's, what's interesting at the moment is you're seeing, you know, continued flows coming into the U.S. but what's been interesting is that a lot of the institutional flow that's coming in is being, is hedged in it, right. So they, so they're hedging the currency exposure because they're worried about the dollar. Now to me, the big thing that really cracks this is we've seen a decent correction in the dollar and we were, I think, one of the few shops at the start of the year who wanted it to be short dollars. We were worried about risk. We thought that we were going to get a sell off starting in sort of November. We're probably a month or so, six weeks too early. But that's, you know, you set your risks accordingly. And then. And the reason we thought that the dollar was going to go down is we thought everyone was long US assets unhedged. So when you got a sell off, all the money was here. Right. So I think a lot will have to do with that dollar because while institutional overseas investors might be hedging retail, that's got, you know, a ton of money, you know, either in mutual funds or whatever, right. Has got the sort of, they're sitting in Germany and they've got the Deutsche bank, you know, US large cap growth fund, right. That will not be FX hedged into euros. So at some point Mr. And Mrs. Schmidt are going to look at that and go, oh, we've made no money or we're down because the currency's moved. So I think the currency is going to have a large role to play. And we've come down to some very important levels on the dollar. We haven't necessarily broken those levels yet. Events in Japan are causing yet more sort of, you know, strength of the dollar. But if and when that does go, and if the administration certainly gets its way on what it wants to do with the Fed, that is likely to happen. I think that's when I think you'll start to see those cracks. You need it. It's. I would hope that it's not. It doesn't come about via a crash, right. I mean, I think this is one of the things that I keep telling my, some of my really sort of earnest precious metal fans, right? There's some technical guys that I like and they have targets for silver of 2 to 300 bucks. And people get very, very excited when you say that, right. For an asset that's trading at 40 bucks, right? And I say, no, no, no, no, no, no, no, no, no. You don't really want to live in a world where silver is 300 bucks. Just think what has had to happen for you to get there. And typically, if you want true precious metal bull markets, not bull markets in everything. Like at the moment we have a pretty much a bull market in everything, right? True precious metal bull markets are born of bloodbaths in the equity market. So the 1930s and the 1970s and the dot com bubble. So like you know, 60, 70% collapses in equities and clearly no one wants that.
- [20:44]
Jack
I want to get back to the stock and bond correlation because I believe in a different podcast I heard with you, you, you called it the most important chart in global financial markets. And we'll have a lot of our listeners that are long term investors that have been in the 60, 40 for 20 and 30 years. It's worked really well. Your bonds have hedged your stocks. And I'm just wondering like in, in the current environment, how should people think through that, think through stocks and bonds as the hedge.
- [21:05]
Julian
So if you go back, there was a Bank of England chart. How the hell they get these charts? You know, there must be some sort of dusty closet that they have somewhere in the bottom of the vaults of the bank of England had a chart going back 250 years up until the early 2000s and it showed basically that the correlation between gilt, so UK government bonds and equities had never been, never been negative. That's between bond and so, you know, they both sold off together or they both rallied together. And why was that? Well, because for most of that time we were battling inflation, right? And starting in 98 when Greenspan came in and did it sort of put around LTCM and started to be focused on disinflation and the risks of the increasingly approaching zero bound. So you know, the sort of rates were getting basically down towards zero. And so central banks would have to be, you know, more worried about their ability to fight deflation. Right? That's when that correlation started to flip. And if you look at the relative performance of a 6040 portfolio, or let's say a risk parity index, which is essentially a leveraged version of a 6040 portfolio, it really just took off in 1998 and early 2000 as that correlation flipped. And that's when bonds became a great hedge to your portfolio. But one of my favorite favorite charts is, and I like to use this to scare some of my real money bond guys and one fund like this trillion dollar bond fund, I don't want to see that chart, Julian, I don't want to see that chart again. And it shows basically the total return of 10 year treasuries, so including coupon, right. Against gold and basically, I mean certainly since 2024, but really actually for an extended period even before that Treasuries relative to gold have just been an instrument of confiscation and the relative performance is just on this swan dive at the moment. So the lesson of the past is I believe that we're moving into a, for numerous reasons into a more inflationary environment. I think it's arguably the right thing to do. We all in the west have far too much debt. We need to inflate that debt away. I think that's, you know, a lot to do with the new plan of the Trump administration which is to, I think to run it hot. Right, to run it hot. I think, as I said, I think that's the right thing to do. But it just means that inflation is going to be a problem and bonds are crap place to have your cash.
- [24:12]
Jack
When you think about inflation being a problem, are you thinking about like 3ish percent inflation like we have now or are you thinking about inflation accelerating again?
- [24:19]
Julian
Look, I think it's, you know, there's, there's some chart fun that you can play when you look at, you know, the cycles of inflation and you look at the sort of 1960s into the 70s and people forget there were really inflation started in the mid-1960s. It wasn't till the late 1970s, though, that it was, was quelled with Volcker coming in. And there were really distinct, like three distinct waves. And I think it's arguable that we're in potentially the beginning of wave two, Right? I mean, a lot will depend on, you know, clearly if we ended up with an equity crash, you're not going to get that inflation, Right? But if we keep pumping this thing up, if the Trump administration is successful in running this hot, then in an environment of, look, gents, we've never really accelerated growth with unemployment in the low fours without creating inflation. The only time we ever did that was in the 19, mid-1960s or late 1960s. And inflation just went straight up because we had no workers, right? We literally had no workers, and we have no workers, right? And we can all sit here and go, AI is going to do it, AI is going to do it. But is it going to do it next year? Is it going to do three years from now? Because if it's three years from now, that's too late. Right? And is it going to do it in the building trade? Because we're going to try and goose the housing market, which is, you know, we declare an emergency in housing and try and lower mortgage rates, and there are various plans under discussions, you know, to try and do that. Well, where are you going to find the workers to build those houses? Right. Where are you going to find the workers to come and renovate your kitchen? Right. And how much are you going to be paying for an electrician then? Right? Because we all know he's bloody expensive now and we should have all been electricians.
- [26:12]
Jack
Yeah, I had some plumbing done recently and it was, it is pretty, it's pretty impressive how much pricing has gone up. So on the idea of no workers, like, how are you thinking about the labor market? I was listening to your podcast with Jack Farley, which I think is the one you were mentioning before, which, by the way, is excellent and everybody should listen to it. And you were kind of talking about how the labor market, at least for the Fed's perspective, is sort of in a sweet spot in terms of them being able to cut right now. Like, it's weakened, but it hasn't weakened that much. But I don't think you maybe necessarily expect that to continue. So how are you viewing?
- [26:40]
Julian
I think there's. Let's look at this. We're in an incredibly unusual situation. We really haven't seen a situation like this where you've seen a loss of momentum in hiring that hasn't led through to firing. Okay. Because that's typically, as you know, night follows day. That's how the cycle goes, right? We, oh, we slow down hiring. We're not hiring. We are firing. Right. And then as soon as you start firing, that's it, right? So all of these people who start saying, oh well, I think we could get unemployment to 5 and then it'll stop there, definitely. Crap. I mean, it doesn't do that. The average rise in unemployment off the lows in the post war recession is about three and a half percent. And given where we were, that would get us to roughly seven. Right. So you're not going to stop at five. Once you lose that momentum and you start laying people off, it's like the rolling ball. It just gathers more and more moss, right. As it just goes. Because you lose your job. You know, Justin goes, oh my God, Jack lost his job. Darling, we probably shouldn't go out for dinner tonight. The server loses their job. You know, that's how it works. So as I said, it's an unusual setup and I think that creates a natural fragility. So I think the Fed is right to be easing a little bit. I don't think they should ease as much as the market thinks they should ease, right? Because let's envisage what could happen. Because just as we could equally break to, unemployment starts to materially rise and then we end up with a recession. Because that's what would happen, right? Let's play a little game where we say we get to next year and the equity markets hung in here. And that's very important because that's typically how companies react. Remember, CEOs are paid to do one thing and one thing only, and that is to be shepherds of the equity of their equity price. They're not paid to produce anything. Up until recent, a few years ago, we didn't even want them making revenue, right. We just wanted this to keep pumping their stock prices up. Right. So let's, we're early next year. Stock market's doing okay. Maybe we've got a big tax refund from, as the president's like handed out cash to, to, to people from the, from the tariffs. They've done something to goose the housing market, right. And that's starting to pick up. The deregulation is picking up. We, the factories are getting built, et cetera, et cetera. And we're trying to do this with unemployment in the low fours. And history would tell you that typically what would happen is that as soon as that unemployment starts to go from 43 to 41 to 3 9, your wages are going to go. And wages drive basically core service inflation. And core service inflation is about 75% of core CPI. And the concept that we have defeated CPI, gentlemen, with core CPI at the highest rates in 30 years is, to excuse my French, a bloody joke, right? So I think it's entirely possible that when you look at this balance, that absent that big equity correction that spring, the summer of next year, we're looking at higher inflation, not lower inflation.
- [30:36]
Jack
You mentioned the no hiring, no firing thing. And I'm also like thinking about the idea that unemployment's higher among people coming right out of college right now. And I'm wondering, do you think AI is a big part of that? Do you think people are looking at AI and they're saying, we know this is going to make our current people more efficient, so we don't want to get rid of anybody, but we're not really sure what's going to happen. Or do you think there's other stuff going on?
- [30:55]
Julian
I mean, I think, look, I think it's clearly an element of that. Although when you look at actually, you know, things like Challenger actually do a breakdown of how many people have been fired because of AI, and it's like 20,000, right, according to their service. I mean, you're not talking hundreds of thousands, Jack. And I think, you know, history tells us it takes and maybe it's quicker because AI itself is smarter and it can help implement. But, you know, we've all seen the stories about how companies are struggling to implement effectively AI. It's not that I don't think it will be effectively implemented. It almost certainly will be. But does it take a couple of years? And so maybe the point is, is I think when you certainly. Look, I spend a long time parsing all the sort of business surveys, so like the PMIs and the ISMs and stuff like that. And the thing that you get time and time again is uncertainty, uncertainty, uncertainty. And I think really more than AI, which has a lot of promise, I think the big thing that's holding people back is that uncertainty that they don't know. They're running things very tight. They're running things very. When you look at inventory levels and all sorts of stuff like that, they are seeing weakness in certain parts of the consumer. So they're worried by that. They are seeing an equity market which looks elevated and they know that that's heavily tied to, to that top 10% who are 50% of consumption in the consumer space. Right. So there's all this uncertainty there. So I think, look, AI is unquestionably playing some element in that reticence to higher. But I think if the aggregate demand were there, if that certainty came back next year, right, and we knew what the tariffs were and we could plan accordingly, but I think firms would be moving forward. And yes, some might not be hiring as many. Right. But as I said, when it comes to building and retail and stuff like that, I don't see the AI replacing. I mean, even if you look at tech layoffs, they are no higher than they were last year. In fact, year over year, they're down slightly.
- [33:12]
Jack
Do you have any views? We think longer term with AI. It's something I struggle with a lot because I see a lot of efficiency in my life from it. But I have a hard time like carrying that up to an overall economy, like to productivity or economic growth. Do you have any thoughts on how to think about AI as we think long term and how it might impact.
- [33:26]
Julian
I mean, I think, look, I think like all technologies, these things are iterative, they're transformative, they take time for businesses to truly structurally implement it and to learn how to use them. So I, look, I use AI quite a lot, you know, and answering questions and improving the speed of which I can write a report. I don't use AI to write my reports because it just isn't stylistically what I do. But I do, I do find them quite useful. I think you have to interrogate them and grill them and you go like, where did you get that fact? Show me the link, right, so that you don't end up spouting rubbish. But I, I do believe that this will get implemented. Now. I think it's quite cute. There's two things, A, that all these AI billionaires are buying. Like, you know, if you look at Zuckerberg, like buying their, you know, their sort of compounds in places where they think might be socially safe, I think that's a little, little bit of a worrying trend. And I think the other thing that the, I would say the AI bros tend to underestimate is let's assume that AI delivers the societal employment transformation that they envisage, right? Who's going to pay for that? Because you've got two options. Either we live in a lawless society that looks something like Max Mad Max Thunderdome, where a few people live in the compound, right. And everyone else, you know, dies in the streets, right? And I don't really want to live in that world, or someone is getting taxed massively to pay for that universal basic income and the only people will be making money are those AI companies. So just ask me what the stock's worth if the tax rate on them is 99%, probably not. What? This is the problem. This is the problem. I mean, look, you know, I don't think it's going there, you know, but it, it's, I think the problem this time is it's, it's, it's transformative in a pretty powerful group of workers, white collar, like educated, powerful, resourceful, politically connected individuals who themselves often support a myriad of other jobs because they're higher earning.
- [36:05]
Jack
I want to shift and talk a little bit more about the, the current economic outcomes we face here. One of the things I think is really great about what you do is I was listening to another interview with you and you know, a lot of people say, oh, we're going to have a recession, we're going to have inflation, we're going to have a soft landing. But you were talking in probabilities and I think that's great because you kind of view the world as we have a percentage chance of recession, a percentage chance of accelerating inflation and we have a percentage chance of a soft landing, which based on what you talked about, it's, it's probably a small chance. I mean, I think you said 3 out of 12 historically tightening cycles have resulted.
- [36:31]
Justin
Yeah.
- [36:33]
Jack
So, so how do you, can you talk about how you think we are where we are right now between those three outcomes?
- [36:37]
Julian
Yeah. So if you go back and look at history and you look at the last. So Alan Blinder, the ex Fed governor, did a study, I think it was in 2022, he looked at the last 10 tightening cycles of the Fed and he gave the Fed like a full 40% success ratio in achieving a soft landing. I think Alan was a little generous to his previous employers. And the reason I say that is when you go back and you look at those instances, yes, there were clear six recessions, unquestionably they tightened too much. Recession right. Straight to jail. Don't collect your 200 bucks. Okay. Then of those four, there was one where in the late 60s where they avoided the recession, but then inflation just exploded. Not really giving him full marks on that one. Yes, you avoided the recession, but that wasn't a soft land. Okay. Then there was another one in the early 90s or late 80s, early 90s where we didn't immediately have the recession. But then, so nine to 12 months later we had a small exogenous sock from a brief price spike of oil in Gulf War one and the economy just hit a brick wall. And to me, that meant that they'd already done enough fundamental damage that it only took a little bit of an exogenous shock to knock us over. So when you look at that, that really doesn't give you. That gives you sort of seven recessions, two soft landings and one where inflation took off again. So those are your sort of based on history. Those should be your starting points of assumption. Okay. Now when I, as I said, when I look at the current setup, I would put the soft landing. I would still probably give it about 20%. I need to see productivity really start to materially accelerate. And there were no. For all the. Oh, it's here. Right. Show me, show me in the data, because I don't see it. Okay. Then I have to look at recession reacceleration. So the recession risk is clearly will occur. If you start to see two things, you get an exogenous shock, which historically is a minor correction in the equity market. Right. At a time when employment is fragile. Okay. So all it needs is that little 10% drop in stocks, dip in confidence for CEOs to go. I'm moving from the not hiring to the firing stage chat right now. Where will I put the odds of that at the moment? Like 40%. I mean, we certainly haven't got a correction in the equity market yet. Those risks will rise materially. If we get one, then I think it would become the base case risk. Then I look at the re acceleration and inflation risk, and I put that at about 40%. Why? Because I think people have constantly underestimated, as I said, the determination of this administration to keep this game going. They have to politically keep this thing going into the midterms. Right. So I think if we get a wobble like I'm. I would expect. Oh, you're getting it. You're part of the tariff refund check is in the mail. Right. It's on its way. We're going to do whatever it takes. Right. Oh, we're getting the GSEs to go and buy mortgage debt and lower the mortgage rate. Right. All of that sort of stuff. And so, you know, and obviously that if that risk starts to rise materially, if you start to see employment rebound. Right. If employment starts to rebound, that risk will rise. So at the moment, I'm just sort of watching all these sort of variables. I'm watching price action. I am concerned with some things that I think people are not watching in the markets, like some of the movements in the credit space at the moment, I think, are a little concerning short term. But, yeah, that's. That's how I sort of square things up. And you play things proportionately. So until that recession, risk rise, which, by the way, has always created the equity market. I mean, I think this is. People forget, even in Covid, where ultimately the equity market went up. It dropped 20% first, right? And then they came in and printed money, right? So if you go back and you look back 90 years, the equity market has never, with a big N, never been up in a recession, and the average decline is 30%, right? So if we go into recession, I think the trade is pretty clear. You sell stocks, right? And unfortunately, you probably sell the stuff that you really want to own as well, unless you're short stocks against it. And that's. You probably sell silver, you probably sell gold, because everything goes down. Just some things go down more than others. And if you. If you can run long shorts, then fine, but if you can't, you go to cash, right? And if we keep going and we run this inflation trade, then you stay long, these things. And that's what I am at the moment. I'm running those, all those very high beta, you know, risk on liquidity play trades. But as I said on the Jack interview, it feels to me like we're, you know, in that roller coaster you've taken off. You sit, you're sitting in the roller coaster, you're getting increasingly nervous. You know that the first drop is coming and it's the biggest, but you're sitting at the back of the bus and you can't see exactly where that turn is. And so your knuckles are getting a little whiter and lighter every minute. But you run it till the price action tells you you're wrong.
- [42:40]
Jack
Just one more for me before I hand it back to Justin. I want to pivot a little bit and ask you about the national debt, because that's something we've talked about a lot on the podcast. I mean, we all know the debt is high. We all know it's rising. And you've kind of got different camps. You've got a camp, and Ray Dalio talked about this a little bit, a camp that thinks we've got a debt crisis coming, you know, maybe in the next few years. And then you've got another camp to say we're going to pay a price for it, but it's probably just going to be higher inflation over time, higher rates over time. We don't have any kind of catastrophe coming. I'm just wondering, how do you think through the national debt and its implications.
- [43:08]
Julian
So I think so. Scott percent was a client of mine for a long, long time and I know that this is probably one of his biggest concerns. And I think he's right. And it's an issue that the Western world faces. It's not just purely a US situation. And arguably, you know, the US is in better situations than certain places. But, you know, it certainly shows less inclination to want to address the problem. Right. I mean, the Liz Truss moment has paralyzed UK governments when it comes to spending money. Right. They are, you know, you're coming up to a budget in the UK and they are going to be raising taxes again. Right. And trying to not elicit the, or cause problems from the bond market. And the US just doesn't care about that. But I do think my sense was in conversations with people that the plan of the Trump administration in a way was to initiate what is essentially an austerity type situation where you impose Harris, as I said, that's a vat, you cut spending, that was doge. And then the resultant correction in the equity market would drive down bond yields. And that will enable you then at that point to term out some of the, of the debt, make that more sustainable. Because we need debt to be running, interest rates to be running at about 2 1/2% to sustain the trajectory of the debt and then hopefully reignite the housing market and then cruise into 2026 right in the midterms. I think what freaked them out was the backup in bond yields. That was clearly not the plan. Otherwise Scott would not have been on TV saying, oh, you should be focused on 10 year treasury yields. Those are the most important thing, right? And then to see them go up, that was not part of the mission, the plan. And so I think now, I think the backup in yields, I think now, as I said, I think the plan is to try and run it this thing hot. And I think that may at some point entail even more financial repression than essentially we have. We already have some elements of, oh, financial repression. Some people call it fiscal QE with this slewing of debt issuance towards the front end of the curve to the bill market as opposed to further out down the curve. But that's what governments have got to do. They've got to play every single trick that they can to slowly boil the treasury investor, the gilt investor, the oat investor, the JGB investor in the pot as they grow themselves out. Now, if things get out of control, then they will do, they will take more extreme Measures. And I don't think, you know, there are many times in history where we've essentially applied fiscal dominance. During the Second World War, we applied fiscal dominance essentially during the Vietnam War. The applied fiscal dominance, it is a necessary step at times of emergency. And you could argue that the trajectory of the debt justifies that. My job is only to say, okay, well if that's the case and that's what you're going to do, what are the consequences? And to position myself accordingly.
- [46:59]
Justin
I wanted to ask you a little bit more about equities here. So are there any other parts of the stock market that you would be sort of maybe favoring or leaning into? Like I'm thinking like maybe value over growth or energy or are there other parts of equities that kind of look appealing to you?
- [47:17]
Julian
So, so historically, in a week, if we're going to get which I think is that probably next stage hasn't happened yet. I'm not pushing these trades right now. If we break and we as I said, we come up to these very sort of long term trend lines on the dollar, if we break lower again, which is my gut, which is where we're going, then typically value outperforms growth in that period. A weak dollar tends to suppress PEs in the US because it reduces that foreign inflow. Because it's less attractive to be invested in the US that you're not getting that double dip from a rising dollar and outperforming US equity market. So if you look at PE ratios and the dollar, they tend to track closely over time. And so when those PEs start to fall, they're highest in the growth stocks, right? So you tend to get a growth value out performance. You also get rate cuts obviously in that situation. Typically that's one of the driving forces behind that wheat dollar which tends to favor those you'd also like. Mining of Metals is one of my personal favorites. Typically you see energy outperform, typically you see precious metals out perform. Typically you see commodities outperform. And typically you actually see emerging markets start to outperform if you get that dollar weakness. So in a way, everything that everyone owns now we're all in US stocks. So if you go and talk to an RIA registered investment advisor, they should say to you as a U.S. investment investor, you should be boss review 65% domestic, 35% overseas. My best is it's 90, 95%. And this is what these guys have basically confirmed to me. US Stocks, right, It's tech, it's consumer discretionary, right? And those are typically the worst performing sectors in a down dollar environment. But once again, the energy thing, I'm a little concerned there because I think we have seen some structural changes in certainly in the oil space. So once again, while I see the price action in things like xme, I don't see it yet in energy. Right. You know, we've seen an idiosyncratic move in copper. It looks somewhere like that. But you're not seeing it in broad soft commodities. Right. And that's typically what you'd see also in a weak dollar environment. So you have to kind of wait to get the price signals before you go, okay, I'm going to sell some of my gold and I'm going to buy, you know, iron or I'm going to buy copper or I'm going to buy, you know, wheat. Right. And that's, that's what those, you know, or oil. Right. And you just clearly haven't got that yet. But those are the sectors that should perform.
- [50:23]
Justin
Are you familiar with Mike Green at Simplify? Do you know who Mike is?
- [50:28]
Julian
Yeah, yeah, I know.
- [50:29]
Justin
Okay, so, and so if you know Mike, you know, he's, you know, made an argument for a number of years about the impact of passive investing on the valuation of the market and it influencing the largest stocks. I'm just curious, where do you have any thoughts on sort of how passive is impacting the market?
- [50:50]
Julian
So I, I, I agree with him 100%. And I also would layer over the top of that kind of my macro framework because I think actually then in addition to the passive impact, and this is really in the US that's most profound because of the preponderance of ETFs, which are less tax efficient when you come to the rest of the world. I would layer over a macro layer which is when the dollar is strong, you get these foreign inflows into U.S. stocks. And to a certain extent it's a mechanical inflow because, and we've called this a reflexive cycle because when the economy, when the equity market is strong, the economy tends to be strong because equities lead employment in the US and they lead for all those things we just talked about and they lead a wealth effect. And that wealth effect is the top 10% who consume 50% of everything and they are all discretionary spending and also tend to have a very high marginal propensity to import. They're the ones going off to the Amalfi cost coast who Scott percent was criticizing. Right. And they're the ones buying the BMWs and so on. And so forth. Right. And that current account deficit has to get funded. And that current account deficit has become humongous. Right, Humongous. It's running about, I mean recently after the blowout in Q1, but we've been running up until then about 4% of GDP. That's a lot of money every single year that we need. It's like $1.2 trillion every year of foreign inflows every single year. Right. To put it in perspective, Whenever Brazil hit 4% of GDP in a current account deficit, the currency got annihilated historically, not just, I'm not talking just a little bit like 70% like collapse. Right. So to go at your point, I think there is a. We've had two forces. We've had everything that Mike's talks about on a micro mechanical basis. And then we've also had this macro effect since 2008 as the US has been exceptional. As I said, I'm not sure that I agree with that. You know, spending like a drunken sailor, whether it's running a large current account deficit or running a large budget set deficit is particularly exceptional. But that has required mechanical foreign inflows and that is in addition layered onto these other micro inflows that Mike Greens micro effect that Mike Green's been talking about. So yeah, I, I completely concurrently that this becomes a virtuous circle or cycle. As long as the forces that underpin that continue. I mean, if you get too, too strong a drop in the dollar, the money will go home, right? It just will leave the US if you get a recession, we won't need the money because the current account deficit will collapse, the money will go home. Right. If we end up that it turns out that we have an AI bubble and the bubble bursts, the money will go home. So this is, I mean, George Soros came up with the concept of reflexivity, which is what I think we have here. So just very briefly, essentially reflexive cycle is a cycle where the purchase of an asset underpins the fundamentals that justify the price of the asset. So that you can create far from equilibrium, which is what most economists assume markets are always in equilibrium. Right. George goes, no, no, no, no, no. They get well out of whack when by buying the asset you underpin the fundamentals that value that asset. And likewise, of course, the converse being, if you sell that asset, you under, you know, you undermine those fundamentals. And that's what I think we're in. And that's why I think there's an enormous fragility here. I'M running risk as we speak. I'm like holding on for dear life because this is where you make your most money. But I'm not naive enough to think that there's an incredible vulnerability here if something does go wrong.
- [55:12]
Justin
And by the way, thank you for explaining what that actually means in that theory. A lot of times people come on podcasts like ours and they talk about things, but you know, our audience might not necessarily be familiar with that. So I think that's a great, just a great example and so appreciate that we have two standard closing questions we like to ask all of our guests. And I'm really interested to see where you go with these. The first one is what is the one thing you believe about investing that most of your peers would disagree with you with?
- [55:43]
Julian
I would say, I think one of the things that I said that we vehemently believe is that we is this incredibly tight correlation between markets and the real economy, particularly in the US it displays itself to some degree elsewhere in the world. But in the US we do believe that we just have this truly hyper financialized economy where to keep the game going. We need ever, ever higher equity prices. And it really scares me if I'm right because it means if something goes wrong in the equity market and I, I do truly fear the US could implode like a, you know, could fold like a house of cards.
- [56:33]
Justin
That is definitely something that so far it's working.
- [56:36]
Julian
Look, I do want to stress so far it is working well, right? As long as the equity market keeps going. Right. But just understand like that, you know, there's a natural gravity once we've sucked in all the money from the rest of the world right into our equity market, which we're increasingly getting to that point. Right. Where does the money come from unless we print it? And that in itself will have consequences.
- [57:04]
Justin
Well, and I think like stock ownership to kind of going back to, you know, Mike's point and the point that you made before is that, you know, stock ownership in this country through 401ks, and even though the wealthy still are the major owners of stocks, I mean, they're much more prolific in people's wealth than they were 30 or 40 years ago.
- [57:23]
Julian
There's a, there's a, there's a confidence metric out there which looks at the size of portfolios over $500,000 and it's steadily risen. But according to this, 35% of Americans now claim to have an equity portfolio of over $500,000. And the scary bit is it's jumped in the last 18 months, two years from 25%. And when did that break occur? When Nvidia took off. Right. So I wrote this piece a few months ago to my clients and I said, I think US Inc. Aggregate, the whole thing is all in on AI the country. The CapEx spending, the employment, the wealth is a leverage play on AI. So we better hope it works.
- [58:24]
Justin
Just one point on that. It is interesting that everyone I hear coming out talking about all this capex spend is kind of like saying like, oh, well, yeah, you know, we did the same thing with, in the Internet where we built out the fiber and then, you know, but stocks went down 80%. So it's almost like they're, they're, they're saying it's, oh, like we're putting all this money into this capex spend and sort of almost acknowledging like, well, we might actually kind of lose a lot of this, but we're willing to do it anyways because there'll be some winners on the backside. I don't know, it's weirder.
- [58:55]
Julian
Look, I think it was an existential crisis for the big players, right? I mean, I read a piece a year or so ago saying, look, I'm not fighting this, but to me this does seem analogous to periods that we've seen in the past where to maintain your leadership in a certain space in the market, you had to spend on AI, right? So if you want to remain number one in search, Google, you have to spend on AI. If you want to remain, you know, number one in social media, meta, you had to spend on AI. I think the problem that potentially investors have, haven't realized is that, you know, those industries in themselves are very profitable, but on the current valuations, you almost need Google to come up with some other new income stream. It's not good enough that they just continue to dominate search or meta, continues to dominate social media. One of them needs to come up basically with a cure for cancer as a result of the spending on AI. And that's if, if we start to realize that that's what we've spent this cash on and the rois are going to take, you know, we can talk about, you know, how quickly they're writing these chips off and all that sort of stuff. Right? But if we just get to a point where people go, oh, they're just continuing to grow at, you know, 15%, which is very good, but they're just doing it in the existing space, is that going to be enough?
- [60:22]
Justin
I know you don't usually, you don't work with individual Investors. But the last question here is, based on your experience in the markets, if you could teach one lesson to your average investor, what would that be?
- [60:32]
Julian
I mean, a. Be invested. I mean, be invested, right? I mean, and say to my daughter, you know, who's 18, like, you got to be invested and you've got to spend. You know, we all tend to late in life go, oh, I've got to start looking at this, right? No, you need to be invest. And for anyone in the U.S. open a Roth. Like as soon as you've got life. Yeah, as soon as you've got any money, open a Roth, right? So yeah, you know that, that's where those are the sort of things that I would be. I would be looking at. Become a student of the market. Think. Be willing to think independently and understand that this is a. We have a whole industry that is just designed to be a cheerleader, right. And sometimes you need to look, you know, not at the cheerleaders, which, you know, we're all males, we all tend to do too much. Right? Is. Is to go. Is to look at the guy in the corner or the girl in the corner of the room who's doing something that's different. Think independently.
- [61:47]
Justin
I don't know, I'm Jack over here, cheerleader over here. I'm pretty much always looking at the cheerleader over there.
- [61:53]
Julian
So look, you know, you ride these trends for as long as. As you can, but if you're a student of history, you know that there is so no such thing as a perpetual money making machine, right? At some point some sort of event occurs, and it might not be now, it might not be next year, right? But you're always kind of trying to weigh those issues up.
- [62:25]
Justin
Thank you very much, Julian. We've really enjoyed this. Appreciate it.
- [62:28]
Julian
Pleasure.
- [62:28]
Justin
Jen, thank you for tuning in to this episode. If you found this discussion interesting and valuable, please subscribe on your favorite audio platform or on YouTube. You can also follow all the podcasts in the Excess returns network@xcessreturnspod.com. if you have any feedback or questions, you can contact us@xsreturnspodmail.com no information on.
- [62:48]
Jack
This podcast should be construed as investment advice. Securities discussed in the podcast may be.
- [62:54]
Julian
Holdings of the firms of the hosts or their clients.